With the rapid acceleration of bitcoin innovation and investments, financial institution relationships are more important than ever. Yet there has been increasing chatter in some circles suggesting a tenuous scenario brewing between emerging businesses in the bitcoin space and the world of traditional banking.
The unfortunate reality is that scores of banks are experiencing discomfort around a rapidly changing regulatory landscape in the financial services industry. As a result, many have taken an unfavorable stance toward businesses that transact in bitcoin and other forms of cryptocurrency, shuttering active accounts with little or no notice or even preventing them from being opened in the first place.
Many of the businesses impacted are often in full compliance with the law, yet they find themselves having to scramble around and jump through hoops in order to establish a secure banking relationship. As a result, the tenor between banking and the cryptocurrency community could be best described with one word: Awkward.
“Banks, in general, aren’t known for their innovative and forward-thinking practices. So when something new comes up that could be risky , it’s a lot easier to them to say ‘no’ instead of finding ways to say yes,” says Ben Reynolds Vice-President of Business Development at the bitcoin-friendly Silvergate Bank headquartered in San Diego, California.
So what’s really behind the reluctance in this space? It stems from regulations that have been put in place, some designed exclusively to protect consumers, others designed to mitigate nefarious acts on the part of terrorists and other bad actors. What has ensued from this situation is heavy, audit-based enforcement activity on the part of regulators, leaving these financial institutions with the burdensome task of justifying their compliance with the law.
Banks in general also are responsible for making sure that their customers are following both the letter and the spirit of these regulations as well. This is where things have gotten quite dicey.
Forging an Effective Banking Relationship
With client businesses both domestic and overseas, Silvergate Bank has been supporting companies in the bitcoin and blockchain space since 2013. Unlike many other banks, Silvergate has done a deep-dive into the regulatory requirements governing digital currency to determine the most effective ways to actively serve their clients.
“There hasn’t been a lot of regulation around bitcoin. As a result, banks find themselves having to think outside of the box in interpreting what these requirements are. At that point they can determine whether a new business entity is following the spirit of the laws they’re required to adhere to,” says Reynolds.
Reynolds goes on to note that an extensive process of due diligence is required to ensure compliance on the part of a business. “There are a few broad categories that we look at here at Silvergate. First, what is the business entity structure, who are its principals, and what type of business is it? Secondly, what are the laws applicable to that particular business and what sort of systems do the businesses have in place to ensure compliance with the laws? Thirdly, are they adhering to all federal and state licensing requirements? And lastly, do the economics make sense. Because due diligence is a very expensive proposition that requires quite a bit of time and money on the part of the bank, we, like, any business need to know what our return on investment is. There are a lot of folks in the bitcoin space that don’t understand this aspect.”
Silvergate has taken major steps in establishing an infrastructure specifically directed toward companies engaged in the cryptocurrency business market. This includes Bank Secrecy Act and Anti-Money Laundering experts as well as attorneys — a compliance team that is highly adept at helping clients navigate the often onerous regulatory waters.
“One of the major things that is often overlooked, particularly by startup bitcoin entities, is compliance in general. The good news is that we’ve seen some maturity in this area over the past couple of years. Three years ago, many of these companies weren’t really clued in as to why compliance matters. Now they are coming to us a bit more educated because they’ve gotten counsel from bankers, attorneys and the like,” says Reynolds.
Charting Treacherous Waters
For many bitcoin and cryptocurrency related businesses, having to engage in regular assessments to determine regulatory vulnerabilities within their organization, as well as developing policies and procedures to define how they’re going to mitigate these risks is a daunting task. There’s also the monitoring process for reporting suspicious transactions. Then internal audits need to be in place to ensure that the compliance process which was designed by the company is working in the manner it was intended to.
Says Reynolds, “We understand that it’s very expensive for our clients to put this type of infrastructure in place. So we’re very sympathetic to how difficult that is. At the same time, some businesses try to do the minimal amount required. These companies really need to view appropriate amounts of compliance as a strategic advantage in ensuring the success of their business over the long haul. Fortunately, many of the clients we are seeing are taking an aggressive, proactive approach to this, some going as far as having conversations with regulators in their state to ensure that they are being proactive and developing the right compliance infrastructure.”
Reynolds believes that as regulators come to understand the space better, that will likely lead to more regulation, which he sees as a good thing in terms of providing legitimacy to the industry. But he says that those who have been light on compliance or have been doing the minimal amount required are likely to find themselves scrambling to compete with other businesses in their space that are being more proactive.
Joe Ciccolo, Founder and President of the Illinois-based BitAML, a regulatory compliance consulting company devoted exclusively to helping digital currency startups and small businesses, says that “de-risking” is a sensitive topic in large part because regulators are continually raising the compliance bar on banks, making an already uneconomical decision to bank bitcoin and other related money service businesses all the more challenging.
“Both bitcoin companies and bitcoin-friendly banks must exercise patience. Bitcoin companies should come prepared, day one, to share their AML program and supporting compliance documentation. But it doesn’t end there. These companies must prepare themselves to field bank questions and produce documents throughout the banking relationship, not just at account opening. Similarly, bankers need to exercise patience with bitcoin companies. Rather than a ‘check the boxes’ exercise, bankers must be prepared to educate prospective and current bitcoin customers as to what information or documents are needed and why. This involves a degree of hand-holding and some added restraint.”
In the end, Ciccolo believes that there will still be those unfortunate times when an open banking relationship is not enough. “Given the current realities of the banking community, bitcoin companies as a backstop should, if possible, maintain multiple bank accounts to minimize the threat of operational disruption.”